Why the Metcash Limited share price has doubled in value this year

It might be hard to believe, but the shares of Metcash Limited (ASX: MTS) have increased by more than 108% since hitting a 52-week low of 96 cents back in September of last year.

This is an extraordinary performance considering that most investors had written the company off just 12 months ago.

What makes this performance even more impressive is that Metcash itself has complained of the same problems facing its other listed rivals in Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES).

All three operators have suffered from price deflation, intensified competition from the likes of Aldi and the need to “invest in lower prices.”

Very few…

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It might be hard to believe, but the shares of Metcash Limited(ASX: MTS) have increased by more than 108% since hitting a 52-week low of 96 cents back in September of last year.

This is an extraordinary performance considering that most investors had written the company off just 12 months ago.

What makes this performance even more impressive is that Metcash itself has complained of the same problems facing its other listed rivals in Woolworths Limited(ASX: WOW) and Wesfarmers Ltd(ASX: WES).

All three operators have suffered from price deflation, intensified competition from the likes of Aldi and the need to “invest in lower prices.”

Very few investors would have predicted that Metcash would be the top performing company in this environment and especially since its own earnings fell by 12.7% in the first half.

So what is behind the share price rally?

I think there are a number of reasons investors have seen Metcash’s share price surge since September, including:

The Masters Debacle – Woolworths’ failed venture into the home improvement sector should prove to be a positive for Metcash. There is the possibility that Metcash will now look to buy some of the better Masters sites to scale up its Mitre 10 business. The failure of Masters will also reduce the amount of competition in the sector which should benefit both Wesfarmers and Metcash.

Improved balance sheet – Metcash recently divested its automotive division to Burson Group Ltd(ASX: BAP) for $275 million. The proceeds from the sale not only helped to improve the company’s net debt position by more than $200 million, but also allowed additional investment into Metcash’s core food, liquor and hardware businesses.

Short Covering – Metcash has been (and still is) one of the most shorted stocks on the ASX for the past three years, with short positions peaking at nearly 25% of issued shares in November 2015. Since then, short sellers have been gradually covering their positions and this has had a beneficial impact on the share price. As the chart below shows, short positions still stand at around 14.5% of issued shares.

Source: www.shortman.com.au

Headwinds for the entire sectorhave changed relative valuations – Investors have realised that Metcash is not the only company in the sector that is facing headwinds. As a result, a price-to-earnings ratio of around 10 for Metcash may be more attractive for bargain hunters compared to either Woolworths or Wesfarmers who are trading on P/E ratios of 16.4 and 19.9, respectively.

Dividends expected to resume in FY17 – According to CommSec, analysts are expecting the company to resume paying dividends with a 7.2 cent per share dividend in FY17. This will obviously be a positive for investors who haven’t seen a dividend declared from Metcash since 2014.

Foolish takeaway

Metcash is due to release its full year results in just over a week’s time and it will be interesting to see the degree of improvement since its last results.

I suspect Metcash, along with Woolworths and Wesfarmers, will continue to face significant headwinds in the supermarket sector in the short term and this means earnings growth is likely to remain subdued.

Motley Fool contributor Christopher Georges has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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